Why Gold Can Still Go Down

The city-state of Dubai announced yesterday that they would not be able to pay the interest on their debt. Dubai, you may remember, saw explosive growth in real estate from 2001 to 2007, but when Real Estate Bubble Wave 1 popped, thousands of investors and residents fled the Middle East state amid collapsing housing and commercial real estate prices.

Fears of a dangerous new phase in the economic crisis swept around the globe yesterday as traders responded to the shock announcement that a debt-laden Dubai state corporation was unable to meet its interest bill.

Shares plunged, weak currencies were battered and more than Â£14 billion was wiped from the value of British banks on fears that they would be left nursing new losses.

Though there was not much action in global stock markets on Turkey Day, as soon as markets opened this morning, stock sell offs around the world began. The Japanese stock market dropped 3.2% (-301.72), Hong Kong fell 4.84% (-1,075.91), but Europe managed to stay in positive territory for the time being.

US Stock markets opened to the down-side, with the Dow being off 180.19 (1.71%) points in early trading.

The most interesting asset class today is gold, which was trading down $27.60 (2.33%) at $1159 in early trading. Why is this interesting? If gold is supposed to be a safe-haven asset, shouldn’t it be rising during times of crisis?

This down move in gold suggests that, while the long-term trend may be in the up direction, the near-term movements of gold are still closely tied to the dollar. If we were to see investors flee equities and foreign currencies in favor of the dollar, as we are seeing on a limited basis today, then not only would stock markets come crashing down, but gold would follow suit.

The Dubai credit delinquency may be a small blip on the financial collapse radar screen, but given today’s action, it can be used to help forecast possible asset class movements in the event of a major stock market collapse.

For those gold bugs who are looking for a better price before moving more wealth into the precious metals classes, there is still hope, it seems.

Contrary to popular opinion, gold may not yet have become the last, safest asset on Earth. Investors may have simply been speculating on the price of gold moving up. For some, it may have been an inflation hedge, but according to the government’s CPI numbers, there is nominal inflation. And, if gold was really a safehaven asset now, then it should have been moving up, not down, on today’s Dubai news.

So, for the time being, we’ll side with those, like Marc Faber,Â who believe gold still has the potential to go under the $1000 mark, even as low as $800 – $900. This scenario may not be the likeliest, but it is still a possibility. Keep in mind that we have seen gold go from $1000, down to $700 in the last 18 months. Who’s to say it can’t happen again?

That being said, we are not selling any of our existing gold positions, simply because the long-term trend is the important one to be looking at. Gold will continue to edge higher over the coming years, not because of speculation or inflation fears, but because it will act as a hedge against government instability and incompetence, as it has done for thousands of years.

If you are trading and trying to make a quick buck, don’t get upset if gold surprises to the down-side in the near-term. For long term investors, gold is a safe haven asset, so hold strong – it’ll pay off in the long run.

UPDATE 11-27-09, 9:45 AM CST:

For further analysis of the market machinations behind the down-ward gold and stock market moves, we recommend Karl Denninger’s article A Sober Reminder on Black Friday:

I will repeat what I have said since the breakout at 1060 on the gold futures – there is no safe place to buy during a parabolic move.Â Yes, today, we stand having lost “only” the last three days of gains.Â So far.Â Better think about how you’re going to hedge off the next $300 of downside move – if it comes.Â No, that’s not a prediction – but the last two days are a warning that it both can and might.

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We are fortunate that this is a “little country” with a “relatively small” impact, even if they truly default and cornhole everyone with exposure.Â Total exposure is claimed to be somewhere around $60 billion – enough to hurt, but not enough to kill.

The dollar carry unwind, along with the other possible disaster scenarios, does not appear to have been triggered by this little adventure – yet.

This should not – and indeed must not, be taken by market participants as a “whew, it’s all ok” sort of signal.

This may instead be the last warning we get.Â The potential for contagion does exist in this situation, and with the markets floating not on fundamental values but rather on Fed-created games and distortions.Â This in turn has encouraged people to lever up, which means that we are once again exposed to a potential margin call tsunami that circles the globe and takes down all asset classes at once in an uncontrolled unwind.

If the SHTF in financial markets, look out below, as US Dollar cash will become an instant, albeit short-term, flight-to-quality-asset.

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I’m confused. Sometimes it seems SHTF posts are written while all the information is still spinning in the logic-opinion mixture. The above is very conflicting; what are you trying to say? The big news of the day shouldn’t be how low gold went after Dubai went bust – but how fast it climbed back up. Just because Circuit City was selling a big screen plasma tv for $800 on its last business day, it doesn’t means I’m getting one for $600 at Best Buy tomorrow.Â (If the premise of SHTF is to be prepared, then it would be advisable to put warning labels on gold theories from those who profit by speculation and day trading. In regards to Faber, shouldn’t we think that the $1000 resistance has been proven ‘real’?)

QUOTE: Sometimes it seems SHTF posts are written while all the information is still spinning in the logic-opinion mixture

Rubles, thanks for your post. SHTF posts are always spinning in the logic-opinion mixture. Sometimes you’ll find that I’ll put a post up, read some comments that shed a different light on the original post and I modify my opinion. I am in a constant state of evolution… or devolution… however you want to look at it, I guess.

The post here was not intended to suggest gold is going down because of Dubai necessarily, but to demonstrate that gold and stock markets remain linked to the dollar for the time being. Perhaps I didn’t do a good job of pulling that off, but this was the intent.

Yes, I would agree with you that the $1000 level is currently resistance as Doc Faber pointed out, but as Faber himself suggested, if gold drops under $1000, it could trigger a long and sharp decline down to as low as $800 on technical selling, etc.

While gold did rebound today after the initial hit it took, it is noteworthy that it was trading down $36 pre-market. (I wrote this post at about 9:00 AM, and didn’t do any afternoon follow-up).Â In a real market crash, I would not be at all surprised to see gold get hammered by $100 or more in one day on panic selling. As I mentioned in the post today, gold is still in the up trend long-term, but it seems to me that gold’s movements are susceptible to speculation and leverage right now, so near-term moves could be quite volatile and violent in eiher direction.

QUOTE: If the premise of SHTF is to be prepared, then it would be advisable to put warning labels on gold theories from those who profit by speculation and day trading.

I try to be as clear ass possible about my personal strategies, and do have a disclaimer/warning at the bottom of this web site. But, comments like yours are probably the absolute best cross-check for anything written on this web site.

I am not a day trader, though I do speculate from time to time to keep from getting board. Since I can’t find a poker game around here for 150 miles, I’ve got to do something to entertain myself 🙂

Aadesh, My personal opinion is that gold will blow through $1100 and head to $2000 eventually. But if you’re looking for a timing call, that I cannot do.

The possibility of gold dropping back under $1000 does exist, especially if we have a serious rally in the dollar and a collapse in the stock market. When would something like this happen? My view would be that late January/early February if retail sales from the 4th quarter are crap. The cyclical analysts like Weiss, Armstrong, Edelson and even Dent suggest that a down-turn may occur as late as April/May. So trying to guess the turning point is impossible. You might as well flip a coin, in my opinion.

At the same time, if the stock markets recover from the Dubai incident and turn back to the upside, gold should keep on keepin’ on to the upside. This has been the recent operating procedure here in the US… for the last 6 months, the markets have completely ignored bad news, forcing just about every asset class up (except the USD, of course).

As mentioned, I play around a little bit with short-term trades, but to be honest, i got slapped around trying to short the market on several occasions this year, so I decided to go ahead and just start focusing on long-term positions and long-term trends. This is no time to be gambling.

I am long-term bullish on gold. In the short-term, I am looking for a correction/pullback, but I will not be participating in trying to short gold or go long the USD. If the markets/gold drop, my plan is to simply acquire more precious metals assets.

This probably doesn’t help your cause in any way, but this is where I stand right now.

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